The Securities and Exchange Commission voted on Wednesday for a resolution that will allow startups to raise funding over the internet from almost every American who wants to invest.
This is the first major step towards equity crowdfunding, which is exactly what it sounds like — crowds of people put up money in exchange for securities in a company that isn’t publicly traded. What could possibly go wrong?
Before, only individuals with more than $1 million in net worth or an income of at least $200,000 for two years running could become accredited investors, and only they could invest in startups.
The new rules specify that startups are allowed to raise up to $50 million in a year through equity, debt or convertible debt-to-equity arrangements from the public and online — stock offerings still need to be “qualified” through a simple process by the SEC. Individuals who want to invest can only invest up to 10% of their net worth. Online equity investment platforms still need to be registered with the SEC as “broker-dealers,” essentially the financial middlemen in buying and selling stocks, bonds and other securities. There are also limitations on soliciting investments through social media, Mashable reported.
David Pricco, editor of CrowdExpert.com, a crowdfunding blog, told Mashable:
“This is overwhelmingly good news, as it opens up a new path for small private companies to raise money directly from their communities, customers, and followers, and a new way for members of the general public to invest in startups, local companies, and new kinds of investment without being ‘accredited investors.’ “
But online investors hoping to snag equity in a company that could explode to become the next Google or Facebook need to know the risks, because there are plenty. Billionaire investor Mark Cuban even suggests that the idea of angel investing and equity crowdfunding is completely idiotic.
Here’s why: There’s significantly more risk when you invest in companies that haven’t gone public yet. A company that reached the IPO level has demonstrated that their company has a solid organizational structure, management team and they usually tend to be profitable.
Startups tend to be bootstrapped, most are never profitable, their CEOs aren’t the most experienced in the game, if at all, and you have no guarantee that they will ever be successful.
You don’t see any returns when you invest in equity of a private company, especially a startup, until years down the road (if ever). You might as well have thrown your money into a bottomless pit, unless you are insanely lucky and that company does go somewhere, but how often is that? The Wall Street Journal claims that 75% of startups fail. According to venture capitalist Fred Wilson, even the best investment firms make flop investments a third of the time.
When a startup that you’ve invested in tanks, goes through co-founder drama, or any of the thousands of other bad things that could turn a company into dust, your money will disappear too. With the stock market, you can at least sell shares before or at the beginning of a storm to save something. Don’t forget about that tech bubble either.
Oh, and for you entrepreneurs out there, good news! It’s now just a little easier to find money and fund your “revolutionary” and “game-changing” app or idea. Happy hunting.